Government fears threat of privacy coins. But their technology will provide major benefits.

By Martin D. Weiss, PhD and Juan M. Villaverde on
August 8, 2018

Monero, Dash, Zcash and similar coins use advanced mathematics to protect the privacy of transactions, and the technology underlying these specialized coins can be very beneficial.

It could help build a solid shield against hackers, safeguard sensitive information and enhance the security of democratic elections.

However, government policymakers are deeply concerned that these kinds of coins might also enable the financing of terrorists, election meddlers, drug traffickers, child pornographers and other malicious actors.

Our view: Privacy coin transactions are currently not a real threat because they represent only a fraction of a percent of total cryptocurrency transactions and are not liquid enough to finance anything.

Meanwhile, cryptocurrencies that adhere to the high standards of transparency pioneered by Bitcoin still provide more than adequate resistance to censorship.

Thus, efforts to discourage the usage of privacy coins for illicit activities would not hurt the crypto industry. Nor would it deny citizens protection from invasions of their privacy.

We’ll make specific recommendations for all concerned in a moment. But first let’s look at this issue from the perspective of the average citizen.

We explained how some governments would like to force all liquid assets under the roof of financial institutions. And we warned how this could adversely impact billions of citizens, especially those under authoritarian, corrupt regimes.

There are two salient risks for citizens in a cashless society:

Risk #1 is asset seizures.

With all financial assets under direct government supervision or control, it could be a lot easier for a malicious regime to confiscate the private assets of individual citizens.

One solution is cryptocurrencies like Bitcoin. Owners can take direct possession of their digital assets simply by creating their own wallets. It’s easier than opening an account on an exchange. And it’s far easier than taking possession of stock certificates.

Indeed, a core goal of cryptocurrencies is to …

• Move away from today’s over-reliance on a centralized banking system …

• Return to the centuries-old practice whereby people own some of their property without intermediaries, and …

• Provide private citizens some protection against bank failures.

We recognize that central bankers may interpret this as an anti-banking, anti-establishment movement. But it’s not. Just compare these two systems, and you’ll see what we mean:

System A. Banks and other financial institutions hold 100% of everyone’s money all the time. What happens if there’s a systemic meltdown like the one that nearly happened a decade ago? These banks risk taking down the entire economy. Alternately, as we saw in 2008, the insolvent banks are deemed “too big to fail.” They’re bailed out. They gain new competitive advantages over smaller banks. And they grow even bigger, ultimately compounding the problem.

System B. Governments foster a mixed financial system that gives individuals and businesses a choice: You can entrust your financial assets to third parties. Or you can take possession and hold them yourself directly via things like cash in your pocketbook or cryptocurrencies in your electronic wallets. This diversifies the custodianship and spreads the risk. Even if there’s a systemic failure, not all assets are frozen. Not all is lost.

System B is more democratic and, in the long run, could be more stable for three reasons:

1. Fail-safe. Yes, banks lose their monopoly power over money. But that gives them an extra incentive to stay out of financial trouble. And in case they don’t, it gives society a fail-safe cushion.

2. More individual freedom. If you so choose, you can own your own money … trade with whomever you want … and do it all peer to peer, individual to individual. No custodians, no gatekeepers, no middlemen.

3. Transparency. With nearly every cryptocurrency, all transactions are transparent. Anyone with an internet connection can track them back to the beginning of time. This means that governments can also see everything that’s going on. And with advanced techniques not available to the public, they can even connect the dots to named individuals, as we saw in the recent Mueller indictment against 12 Russian cyber sleuths.

Risk #2 is invasion of individual privacy.

As we explained in Part 1 of this series, a society that’s devoid of physical cash can also be risky for another reason: It becomes virtually impossible to buy or sell anything without official tracking.

If you’re fortunate enough to live under a moral, democratic regime, this is typically not a concern.

On a scale of 0 (highly corrupt) to 100 (very clean), more than two-thirds of the world’s governments score below 50, indicating very significant levels of corruption. Worse, those countries account for about 85% of the world’s population.

This map tells the story at a glance:

All countries colored red and dark brown are in “corrupt” or “highly corrupt” zones.

Only those colored orange and beige are in the “clean” and “very clean” areas.

Clearly, your concern about privacy intrusions is likely to vary greatly depending on where you live.

If you live in countries like New Zealand (scoring 89) or Denmark (88), you’re likely to support giving your government all the tools it needs to protect you from bad actors.

But if you live in countries like Venezuela (18), Russia (29), Mexico (29), Pakistan (32), Brazil (37), or China (41) and you accept Transparency International’s findings, you probably see both bad actors and government officials under a similar dark shadow. You want to protect yourself from both.

So the solution here is more complex and controversial:

Just as citizens living under corrupt governments have valid reasons for making certain transactions in private … governments seeking to curb bad actors have valid reasons for monitoring them.

Citizens ask:

• What good is my money if every dime I spend can trigger an instant notification to corrupt governmental officials?

• What good is my money if that information can be used against me in a kangaroo court?

• What good is wealth if it becomes the rationale for stripping me of my political rights or throwing me into jail?

Governments ask:

• How can we deal with election meddlers, cyber attackers, drug traffickers, child pornographers and terrorists if we can’t even track their financing?

• How can any honest citizen support cryptocurrencies that are used to cloak all these horrible activities?

It’s these kinds of questions that underlie the controversy about privacy coins, such as Monero and Zcash. They could make it next to impossible for even the most advanced intelligence agencies to know who owns or sends what, where or when.

With privacy coins, all that can be known is gross total stats: The overall market cap. The sum of all transactions. And that’s about it. Who and how much is involved in each individual transaction CANNOT be known.

This privacy-enhancing technology is not bulletproof, of course. In theory, there’s bound to be some way to break the encryption. But in practice, it would take so much time — and such massive resources — that even a well-funded government agency would be hard-pressed to catch up with bad actors.

Now the big question: How can citizens and their governments balance the benefits and the dangers of this technology?

Fact #1. Like any technology, Privacy DLT is neutral. In and of itself, Privacy DLT is neither “good” nor “bad.” Rather, good actors will use it for legitimate purposes; bad actors, for illegitimate ones.

Fact #2. Privacy DLT already exists. Even if a country seeks to enforce a blanket ban of Privacy DLT, it will not snuff it out. It will merely prevent its legitimate application, while giving criminals a virtual monopoly on its illegitimate usage.

Fact #3. It may be impossible to ban Privacy DLT. But it should be possible to restrict its use cases.

At their core, cryptocurrencies are simply internet protocols for exchanging data. It’s nearly impossible to ban Bitcoin. Which means it’s also nearly impossible to ban Monero, Zcash, Dash or any other privacy coins.

Never forget: By definition, criminals routinely break rules that are more easily enforced. So why should they obey a ban that’s extremely difficult to enforce?

As Andreas Antonopoulos puts it: You cannot ban crypto in your country. You can only ban your country out of crypto.

Fact #4. Privacy is a critical aspect of any democracy. At the same time, cryptocurrencies aren’t just digital money. They also embody an entirely new model of governance. One with the potential to support virtual nations, each with their own constitution and legal system.

Distributed Ledger Technology — the computer software that underlies all cryptocurrencies — offers governments the opportunity to move antiquated voting systems into the digital age. But it cannot do so effectively without Privacy DLT, the same advanced cryptography that’s being developed for privacy coins.

Privacy DLT is a technology that can guarantee the anonymity and privacy of voters, precisely what’s essential for secure, democratic elections. Thus, the same kind of Privacy DLT that Zcash uses for shielding transactions can also be used to create a fast, efficient, anonymous, and secure voting system.

The Benefits of Privacy DLT

We can fully understand why governments might be leery of privacy coins as a form of money. What we find difficult to understand is why they’d be leery of non-monetary applications of the technology.

Privacy DLT can also be used to:

• Thoroughly protect the privacy of personal information. Remember Cambridge Analytica! Their intrusion into private user data was possible because a central authority, namely Facebook, owns that data. In contrast, by using privacy DLT, the social media sites of the future could look radically different: Users will own their own data, which is protected by advanced cryptography. And they will access it exclusively via their own digital signature.

• Build a solid shield against hackers. By moving sensitive data off centralized data centers and using advanced encryption, mass security breaches will be virtually impossible. You would not see break-ins at institutions like Equifax, one of America’s largest credit rating agencies, where hackers stole the personal information of 145 million Americans. Nor would we have seen the disaster at Target, where 70 million retail accounts were hacked, or at JPMorgan Chase, where the private data of over 70 million bank customers was stolen.

• Make sensitive government information safer. Cyber spies can penetrate firewalls all they want. But as long as officials keep their keys safe, the attackers will find nothing to steal. Classified information will be split into thousands of pieces and stored on tens of thousands of servers spread over countless locations. Even government staffers will not have access to more than the specific items they absolutely need.

Bottom Line

The same privacy technology that can be used by criminals to obscure and disguise their activities can also be utilized by governments, companies and citizens to encrypt data and deny access to those criminals.

The technology already exists. The bad actors can already use it. Now, the question is: Will nations leverage this technology to help create a more robust society in a rapidly evolving digital age?

Here’s what we recommend:

1. The public should avoid privacy coins until the controversy and uncertainty surrounding their usage are resolved.

2. Investors should invest in cryptocurrencies that enjoy better scalability and transaction volume, focusing on those that earn Weiss Ratings of B- (good) or better, such as Cardano (B), EOS (B), and Stellar Lumens (B-). Highly liquid cryptocurrencies that currently merit a C+ (fair) rating, such as Bitcoin, Ethereum and Ripple can also be staples in a diversified cryptocurrency portfolio.

3. The cryptocurrency industry should continue to encourage the development of cryptocurrencies that provide a high degree of transparency in all transactions, while supporting government efforts to reduce malicious usages.

4. It’s neither possible nor desirable for governments to ban privacy technology. Instead, they need to clearly differentiate between the threats and the benefits — the illicit use of the privacy coins vs. the positive applications of their technology. Authorities in Japan, for example, forbid the listing of privacy coins on exchanges. Other governments may want to do the same, while leveraging the privacy technology to protect sensitive information and safeguard democratic elections.

Best,

Juan and Martin

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Comments 1

SoretAugust 11, 2018

New York State Department for Financial Services authorized the usage of Zcash for trading in New York State, this is in one part can be thanked for Zcash Company’s educational role where they were educating legislators about application and usage of the technology. They also have approved both addresses for usage such as t-addresses which are transparent and z-addresses which are hidden. Therefore Zcash became the first privacy coin approved to operate and trade in New York State where the cryptocurrency regulations are the toughest.

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